'CHANGE OR DIE': Why Federated Media Has To Reinvent Online Advertising All Over Again

Federated Media Publishing was once a game-changing startup poised to shake up the digital advertising world.

Now, it's the one that's been shaken by a fast-moving industry, with layoffs and turnover in its executive ranks.

In its heyday, the groundbreaking startup sold ads for some of the fastest-growing websites, including Mashable, TechCrunch, and Business Insider. It raised a $50 million venture-capital round in 2008 after walking away from a $100 million buy-out offer.

But for the past few years, it has drifted from its original vision of upending the established advertising order, getting into the very business of commodity ad sales that it hoped to replace.

While the company says its revenues have doubled in the past three years, it's not clear if that's fast enough to meet the expectations of growth-hungry investors. And its not clear if its now-muddied vision can keep the talent it needs to execute its plan.

The business model that gave Federated its edge over the competition—direct sales of ads, with humans talking to both ad buyers and publishers—is now seen as a hindrance. FM recently laid off 24 employees, mostly in sales, and said it would stop pursuing banner-ad business except through automated sales. Even before that, employees were leaving in droves. One former employee called it a "mass exodus."

What's going on? And what will happen to FM?

We spoke with a number of people familiar with the company, as well as its founder John Battelle and CEO Deanna Brown, about what's going on at FM.

It's a tale with lessons for any startup leader who must wrestle with sticking to an original vision, versus listening to customers and adapting to the market's demands. As FM, Zynga, and many other Web 2.0 companies are finding, you need to change with the markets if you want to survive.

When FM was founded, things were different

When Federated Media launched in 2005, it was an easy way for advertisers to reach smaller, quality sites in one fell swoop.

It also pioneered what Battelle dubbed "conversational marketing"—highly customized advertising adapted to the format and audience of the websites it represented. Its innovations, particularly with the social news site Digg, presaged what's now called "native advertising," like Twitter's Promoted Tweets and Facebook's Sponsored Stories. These formats replace standardized banner ads with specialized units which fit naturally in the services where they appear.

FM's early business was tough from a revenue standpoint, though, because virtually all of the inventory Federated Media sold to advertisers came from sites it didn't own. Federated Media had to give a large portion of its sales—about 60%—to the sites it represented. (Later deals were less generous to publishers.)

But there wasn't another solution like it. Advertisers could either buy dirt-cheap, leftover advertising inventory from networks like Google's AdSense, Casale Media, or Collective, with no say in placement or timing—a business known as remnant advertising—or they could pay high prices and buy from each site directly, which wasn't efficient. In most cases, FM's sites were small Web-publishing shops without their own business staff.

As a result, Federated Media became both media buyers' and small publishers' first choice. And while it kept offering conversational marketing programs, more often than not, customers wanted banners, which were simpler to buy and sell.

As an industry, Battelle says, "we messed up when we decided banner ads would be how we make money on the Web."

As for Federated, Brown says that brokering banner-ad deals, especially in the period after the 2008 financial crisis, was a way to make money for its publishers, "which is what we're all about."

Since then, the digital-advertising landscape has changed significantly. Now when advertisers buy conventional banners, they're increasingly making decisions based on real-time audience data rather than the site's content. That data is most easily surfaced by technology and trading desks, not salespeople.

While FM still has a direct sales business, the company has become much more like an ad network than John Battelle anticipated when he created the company.

"The company has changed," he acknowledged. "Because if you don't change, you die."